Bank of England voted 8-1 for steady rates

Blanchflower called for cut; some saw arguments for rate rise

By

WilliamL. Watts

LONDON (MarketWatch) -- Some members of the Bank of England's Monetary Policy Committee weighed arguments for raising rates to combat rising inflation pressures at their June 5 meeting, while David Blanchflower repeated his plea for further easing amid fears of a U.S.-style, housing-led slowdown, according to minutes released Wednesday.

In the end, members voted 8-1 to leave the key interest rate, the bank rate, on hold at 5% -- a tally in line with market expectations.

Consumer price inflation had hit an annualized rate of 3% in April, committee members noted, reflecting upside pressures across a range of prices.

Moreover, inflation looked set to accelerate as oil prices continued to rise and other inflation indicators jumped. Other indicators showed cost pressures were moving along the supply chain, with data showing sharp rises in import prices and manufacturing input and output prices.

However, many of the factors behind the inflation rise appeared temporary, the minutes said, and should allow the inflation rate at some point to move back toward the government's 2% target.

Still, the short-term deterioration in the inflation outlook was enough to prompt some members to "to consider whether an immediate rise in Bank Rate was warranted," the minutes said. "If there were a serious threat to medium-term inflation expectations then a preemptive rise in rates would be appropriate. Delay would only increase the eventual costs of bringing inflation back to target."

There were also "a number of arguments against" a hike, the minutes said, including indicators that suggested inflation expectations over the medium term remained anchored.

Meanwhile, tight credit conditions, rising risk premia and a steeper yield curve were tamping down demand and were appearing more likely to affect the real economy, the minutes said.

MPC members were also reluctant to surprise the markets with a June rate hike.

"An unexpected increase in Bank Rate might be counter-productive by appearing to exaggerate the Committee's concerns about the medium-term prospects for inflation. The Committee should continue to judge, one month at a time, how activity growth and inflation expectations developed in response to slowing demand and rising short-term inflation," the minutes said.

Don Smith, an economist at ICAP, said the minutes were "surprisingly dovish" given the inflation backdrop.

"The discussion of the possibility of a rate hike was predictable, given the economic data, and less significant than the fact that this idea appeared to be so comprehensively dismissed by the committee," Smith wrote in a research brief.

For Blanchflower, who has repeatedly urged more aggressive rate cuts, similarities between developments in the United Kingdom and the U.S. slowdown warranted quick action, the minutes indicated.

Blanchflower argued that rapidly falling U.K. house prices were likely to have a bigger impact on household spending than projected by the committee's May Inflation Report.

"Although a recession in the United Kingdom was not the central expectation, there was a small but growing risk of a very negative outcome that would cause inflation to undershoot the target in the medium term," the minutes said. "For this member, an immediate reduction in the Bank Rate was warranted."

BOE Gov. Mervyn King was joined by deputy governors Rachel Lomax and John Gieve and MPC members Kate Barker, Charles Bean, Tim Besley, Andrew Sentance and Paul Tucker in voting to leave rates on hold.

The MPC cut the bank rate three times between December and April, but rising inflation pressures have prompted markets to begin factoring in the potential for rate hikes over the next year.

Expectations for tightening were eased back Tuesday, however, after King told Chancellor of the Exchequer Alistair Darling that the central bank would aim to bring inflation back in line with the government's 2% target over two years, warning that attempts to bring commodity-fueled inflation down more quickly could cause a severe downturn that would allow the inflation rate to undershoot the target. See full story.

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